International Foundation of Employee Benefit Plans
October 1, 2013
By Aon Hewitt

Canadian defined benefit (DB) pension plans saw a marked improvement in solvency funding in the third quarter of 2013, according to the latest survey by Aon Hewitt, the global human resource solutions business of Aon plc (NYSE:AON).

The survey of more than 275 Aon Hewitt administered pension plans from the public, semi-public and private sectors, indicates that the median pension solvency funded ratio, or the ratio of the market value of plan assets to liabilities, increased to 88% by September 30, 2013. That is 11 percentage points higher than at the end of June and 19 percentage points higher than it was at year-end of 2012. The solvency funded ratio measures the financial health of a defined benefit pension plan by comparing the amount of assets to total pension liabilities in the event of a plan termination. [EXPAND Read more]

“The significant improvement of solvency ratios in Canadian plans means that the average Canadian DB plan has erased more than 50% of its solvency deficit since the beginning of the year. For the strategic plan sponsor, this result in a significant reduction in their minimum required contributions in 2014 and beyond,” said Will da Silva, Senior Partner, Retirement Practice, Aon Hewitt. “The potential reduction in contributions gives sponsors greatly increased financial flexibility as it not only reduces the level of required contributions, but it could also provide some plan sponsors with cost certainty over the coming years.”

The improvement in the solvency ratio resulted mainly from stronger equity market returns and higher long-term interest rates, which rose by 0.4% in the quarter. Further improvement can be attributed to sponsor contributions to the plans to meet minimum solvency funding requirements.

The performance of equity markets was relatively strong in the third quarter. Worldwide, equities gained 6.4%, led by non-North American (10.0%), Emerging Market equities (4.6%), U.S. Equities (3.4%) and Canadian Equities (6.7%). Alternative asset classes such as Infrastructure and Global Real Estate improved their returns over the previous quarter, with 4.9% and 0.9% respectively.

“Improved market conditions, interest rates, and contributions meant that all three of the major factors that influence plan solvency were aligned favourably for plan sponsors in the third quarter,” said Ian Struthers, Partner, Investment Consulting Practice, Aon Hewitt Canada. “Plan sponsors who were strategic in managing their assets within a risk-based framework really benefited. The result was the best solvency ratio in almost three years, creating an opportunity for sponsors to initiate or build on de-risking or funding strategies. Now is the time for them to take action.”

The graph shows the changes to assets, liabilities and funded ratios for the survey’s median pension plan since January 1, 2010.

“Aon Hewitt’s median is an accurate representation of the financial health of the Canadian pension plan universe,” Struthers said. “It takes into account the specific features of each of the plans included in our large database as it based on real data, and capture the effect of each individual plan’s investment policy, actual contributions, and any solvency relief measures adopted by the plan sponsor.”

Approximately 85% of the surveyed plans had a solvency deficiency at the end of the third quarter, compared with 95% in the previous quarter.

“While it was generally a favourable quarter for the average Canadian DB plan, there were headwinds for some plans that provide benefits indexed to inflation to retirement. With the recently released guidance from the Canadian Institute of Actuaries, the improvement in the solvency ratio for some plans may not have been as significant, depending on the province where they are registered,” said da Silva.

Impact of de-risking As well as the typical plan, Aon Hewitt has also tracked the performance of a plan that has employed a few simple de-risking strategies since January 1, 2011. Namely: Increased investment in bonds from 40 percent to 60 percent of the portfolio, Investment in long bonds instead of shorter duration bonds to better match liabilities.

The de-risked plan would have experienced a 92% solvency ratio at the end of September 2013 as opposed to 88% for the median plan. [/EXPAND]